Getting Out: Important Points for Selling a Franchise
Aside from “How much money can I expect to make?” perhaps one of the most common questions asked by prospective franchisees is, “What is going to be my exit strategy?” In reality, there are two distinct components to this question. The first has to do with getting out if the franchisee is unsuccessful in operating the business, and needs to move on to a new business venture. The second has to do with getting out if the franchise becomes a valuable asset, and it makes more sense for the franchisee to profit through a sale rather than through continuing to operate the business.
In either case, the franchisee’s right to sell the franchise will be governed by the transfer provisions in their franchise agreement.
Most franchise agreements contain strict limitations on the franchisee’s ability to sell their franchised business. Fundamentally this makes sense, as the franchisor needs to make sure that it has final say over who gets to do business under its name and using its proprietary system and methodologies.
Typical Restrictions on Franchise Sales Include:
- The purchaser must meet the franchisor’s then-current qualifications for new franchisees
- The purchaser must sign the franchisor’s then-current form of franchise agreement
- The franchisee must cure all defaults (including payment defaults) under the franchise agreement prior to the sale
- The franchisee’s execution of a general release, waiving all potential lawsuits against the franchisor
- The franchisor approving the financial terms of the sale
- Payment of a transfer fee
Depending on the circumstances, these restrictions may constitute significant roadblocks, or they may not be much of an issue at all. Obviously, if the potential purchaser does not meet the franchisor’s qualifications, then the deal will not move forward. Similarly, if the franchisee is unable to satisfy its outstanding obligations, the franchisor may opt to exercise its right of termination, thereby effectively taking full control over (and all of the benefits from) finding a replacement franchisee.
If the buyer is financing a substantial portion of the purchase price, this too may cause concern for the franchisor. The franchisor will want to make sure that the buyer can meet its financial obligations under the franchise agreement (in addition to paying its other bills as they come due), and is not overextended as a result of a hefty loan.
The Franchisor’s Right of First Refusal
Another transfer restriction common to many franchise agreements is a right of first refusal ("ROFR") for the franchisor to buy back the franchise. Essentially, this provision states that if the franchisee finds a bona fide purchaser, the franchisor can step in and buy the franchise on the same terms that were offered to the third-party buyer. ROFR or first refusal provisions can prove to be sticking points for potential buyers, who do not want to go through an extensive due diligence and financing processes only to have the franchise opportunity deal taken off of the table at the eleventh hour by the franchisor. Typically, where a ROFR provision is a concern, it can be proactively addressed so that all of the parties to the process are on the same page.
Finally, when looking to sell their franchise, franchisees need to be cognizant of their continuing obligations after they exit the franchise system. The most important of these restrictions are the non-competition and non-solicitation covenants in the franchise agreement. If a tax preparer, for example, sells their Liberty Tax Service franchise or H&R Block franchise, they need to make sure they can continue to make a living even if they are prohibited from operating a competing business for the next two or three years. Similarly, even if the selling franchisee is able to start a competitive business, they may still be prohibited from taking advantage of the customer list and goodwill they developed during the term of their franchise agreement, as these assets were built by leveraging the mark and processes of their former franchisor.
By carefully and fully analyzing all of the conditions and ramifications of selling a franchised business, franchisees can better position themselves to smoothly transition into their next business venture.
Jeff Fabian is the owner of Fabian, LLC, a boutique intellectual property and business law firm serving new and established franchisors and prospective franchisees. Contact the firm directly at 410.908.0883 or firstname.lastname@example.org. You can also follow Jeff on Twitter @jsfabian.
This article is provided for informational purposes only, and does not constitute legal advice. Always consult an attorney before taking any action that may affect your legal rights or liabilities.
18 Questions for Potential Franchisees to Ask Themselves: Part 1
Franchises are among the most profitable business options available, but potential franchisees often have no idea what they should know or ask themselves before they get started in franchising. We've talked to franchisors and franchisees to compile this list (In a two-part series) of the 18 questions you must ask yourself as you explore getting into franchising.
5 Fast Growing Franchises in 2015
Which franchise should you open? There are a lot of factors that go into that decision, but one criterion that you absolutely have to consider is how quickly that franchise is growing. You can imagine what it would have been like to open a McDonald’s way back in the 60’s or 70’s, seeing that it has turned into one of the most successful franchises of all time.